Odds of QE3 have gone up in last 2 mths: Nicholas Ferres

In an interview to CNBC-TV18, Nicholas Ferres of Eastspring Investments finds it difficult to predict how global markets will react to the Spanish aid agreed to over the weekend. As markets gear up for the Greek election results on June 17, he says many details on the other problem -the recapitalisation of Spain’s banks have yet to be negotiated and worked out.

“While the Euro region agreeing to lend 130 billion euro to Spain is an important event, the positive aspect of it is that at least the authorities in Europe seem prepared to back the Spanish banking sector,” adds Ferres.
He says the odds of a third round of quantitative easing from the Federal Reserve have risen significantly in the last two months. "We have seen deterioration in trends - employment growth or payroll growth which to some extent were expected, but nonetheless you have seen a moderation in employment growth in particular, which has been quite disappointing for markets," adds Ferres.

Below is an edited transcript of his interview. Watch the accompanying video for more. Q: You are going with a tactical overweight on India now. What is that call premised on? What kind of upside would you work with for India?
A: We have moved overweight India for the first time in five years. It’s quite a significant move for us. We have started to reduce our underweight to emerging markets overall.
The key thing for us is valuation. India has been de-rating for about 18 months or two-years now. Certainly valuations of stocks have started to price in the sort of deterioration in investments and returns that we have seen in India over the last couple of years. You have seen return on equity (RoE) decline from about 24% to about 16% on a sort of trend basis or profitability. So, we think a lot of the bad news has largely been put in the price. Q: How do you think global markets will react to the Spanish bailout over the next few days leading up to the Greek election results? Do you think at the end of this 10 day period, given what politicians and central banks do, markets will still come out of it okay on a risk-on mode?
A: It’s very difficult to say. When I was reading through the detail over the weekend, I wasn’t entirely sure which way the markets would react. At least in Asia, so far this morning it’s been a fairly positive reaction. Broadly, the way they have characterised this is, that it’s an agreement to agree on something. So, there are still a lot of details to be worked out.
But the positive aspect of it is that at least the authorities in Europe seem prepared to back the Spanish banking sector. Having a deposit guaranteer and a broader move towards a banking union is a very key part of the strategy in order to stabilise the banking markets and the funding markets in Europe.
So, this is quite an important step. But there are still lots of details to be worked out. So, the trading of markets going into next weekend could still be relatively mixed. In the near-term it looks like a positive reaction. Q: Are you characterising this as a relief rally because of the expectations of regulatory action or do you think we are putting a floor to the market this summer and we can extend this rally through the next few months?
A: It’s an important step. Certainly, a lot of details need to be worked out, but its part of the broader policy response that I expected because the alternative for Europe is absolutely catastrophic. They need to put a floor under the markets and take some of these steps in order to stabilise asset prices and financial conditions. Otherwise, the alternative would have been very bad indeed.
Part of our movement into reducing our underweight in emerging markets by adding India is part of the policy response that happened in this part of the world as well. You have seen policy easing from a number of emerging market central banks, including, the RBI. Last week’s interest rate cut by the PBoC in China is an important signal that you are getting policy support and response from emerging markets as well. Q: There is a school of opinion that seems to suggest the bigger problem over the course of the next few months may become the US and not so much Europe. By the time we are done with this year, we could be staring at a full-fledged recession scare from the US. In that how likely do you think any kind of QE action may be?
A: Bernanke’s comments seemed to disappoint markets a little bit, but I suspect that the odds of quantitative easing have gone up quite dramatically in the last couple of months. We have seen deterioration in trends, employment growth or payroll growth which we to some extent expected because we think to some extent a payback from the strong weather related payrolls in Q1 of the year. Nonetheless, you have seen a moderation in employment growth in particular, which has been quite disappointing for markets.
Markets have started to worry about the growth prospects in the US as well. We have got significant fiscal tightening potentially next year if nothing else changes. I think the market has probably become a little bit too concerned about that in the short run so, that combined with policy support out of Europe, China and other emerging markets should lead to a risk-rally over the next couple of quarters. Q: What kind of window would you approach any bounce back rally with? Do you think it’s got more duration over here or do you think it’s going to be short-lived and how the year closes is still up in the air?
A: I think it is underway. To some extent, I would also characterise the rally that we are starting to see in the last couple of days as - one because of valuations and two because markets were clearly oversold. It probably shows positioning in markets like the Euro where many investors were extremely short the euro and other risk-on currencies.
So, that plus valuation is leading to a rally. How sustainable it is, is to some extent dependent on policymakers and policy actions out of Europe. Hopefully, this is a step towards stabilising the situation, but it could clearly deteriorate quite rapidly still from here.